Is That a Virtual Dollar in Your Pocket?

We might be reaching the point where virtual currencies start to pose a real challenge to the existing ones: the dollar DXY +0.06% , euro EURUSD -0.04% , yen USDJPY -0.04% and pound GBPUSD -0.78% . Indeed, at the end of last year, the ECB put out a paper warning about the competition from these new currencies. Although still small, the paper suggested they might undermine the credibility of national currencies.

It is not hard to see why central bankers are worried. Right now, virtual currencies are tiny. Hardly anyone is taking them seriously. And yet people are increasingly losing faith with traditional currencies. They are losing value steadily to inflation. And quantitative easing and currency wars mean they are constantly being debased. They are open to alternatives.

Plenty of investors have been turning to gold. Russia and China are building up their reserves, and so are many private individuals. But gold has always had its own problems as a currency. After all, if it was perfect the world would not have stopped using it as a currency. It has irregular supply. And it is as prone to crashes and collapses as any other monetary unit.

There is little doubt there is a demand for virtual currencies. They are, of course, completely untested. But with so much of the world’s business now conducted online there is little reason why currencies shouldn’t be minted online as well.

Money is whatever two or more people agree it is. Giant tablets, gold coins, bits on a hard drive. Virtual currencies have an advantage in that central banks can't just print them up willy-nilly, at a time when trust in government is reaching critically low levels.

Commerce must be conducted by some means people can trust. That trust is largely blown, but we don't yet have a replacement for central banks. Not really. That could be a scary transition. But the really scary one is when trust breaks down completely, and contract and security solutions go private.